Taxes from postpetition farm sale are not dischargeable.

• Author: Beavers, James A.

The Supreme Court ruled that taxes on gain from the sale of a farm after its owner had filed a Chapter 12 bankruptcy petition were not taxes incurred by the bankruptcy estate.

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Background

Lynwood and Brenda Hall petitioned for bankruptcy under Chapter 12 of the Bankruptcy Code and sold their farm shortly after. They initially proposed a plan of reorganization under which they would pay off outstanding liabilities with proceeds from the sale. The IRS objected, asserting a federal income tax of $29,000 was due on the capital gains from the farm sale.

The Lynwoods amended their proposal to treat the income tax as a general, unsecured claim to be paid to the extent funds were available, with the unpaid balance discharged. The IRS again objected, arguing that taxes on income from a postpetition farm sale remain the debtors' independent responsibility because they are neither collectible nor dischargeable in bankruptcy.

The Bankruptcy Court sustained the IRS's objection (Hall, 376 B.R. 741 (Bankr. D. Ariz. 2007)). Under Chapter 12, farmer debtors may treat certain claims owed to the government resulting from the disposition of farm assets as dischargeable, unsecured liabilities (11 U.S.C. [section]1222(a)). Under 11 U.S.C. Section 503(b)(1)(B)(i), these claims include a claim for "any tax ... incurred by the estate." The Bankruptcy Court reasoned that because a Chapter 12 estate is not a separate taxable entity under the Internal Revenue Code, it cannot "incur" taxes for purposes of Section 503(b). A district court reversed, in its opinion expressing doubt that Internal Revenue Code provisions are relevant to interpreting Bank-ruptcy Code Section 503(b). Based on the legislative history, the district court determined that Congress intended Section 1222(a)(2)(A) to extend to the Halls' postpetition taxes (Hall, 393 B.R. 857 (D. Ariz. 2008)).

The IRS appealed to the Ninth Circuit, which reversed the district court (Hall, 617 F.3d 1161 (9th Cir. 2010)).The Ninth Circuit held that the Chapter 12 estate does not "incur" the postpetition federal income taxes for purposes of Section 503(b) because it is not a separate taxable entity under Secs. 1398 and 1399, and the court found that Congress has repeatedly indicated the relevance of the Code's taxable entity provisions to the Bankruptcy Code. Although it was sympathetic to the view that the postpetition tax liabilities should be dischargeable, the court held that "the operative...